David Cameron and the German Chancellor Angela Merkel have failed to reach a deal on the Prime Minister's demands for a cut in the EU budget.

Two hours of talks over dinner at 10 Downing Street were dominated by the budget row, which will be debated at a summit of European leaders in Brussels in two weeks' time.

Despite the failure to reach an agreement at the dinner, a Downing Street spokeswoman said the discussion had been "warm and friendly".

"Their conversation focused on preparations for the EU budget negotiation at the European Council later this month and the options to restrain and reform EU spending," she said.

"They agreed on the importance of the EU demonstrating that it responds to public opinion, especially in difficult economic times. They discussed financial stability in the Eurozone and the proposal to create a Eurozone banking union ahead of the December European Council."

Image Caption:The Prime Minister is due to head to Brussels for EU budget negotiations

But the two leaders clashed over what they regard as the EU's most urgent priority.

After a humiliating Commons defeat on the EU budget last week, Mr Cameron is demanding a cut, while the German Chancellor insists the Eurozone crisis is the top priority.

Before sitting down to a dinner of spinach and mushroom tart, venison and vegetable and traditional German cake, Mr Cameron was asked whether he would be urging his German counterpart to support a cut or a freeze in the EU budget.

"I believe it would be wrong for the European budget to increase at a time when we are having to make difficult decisions not just in Britain but all over the European Union to get our budgets back to balancing," he said.

Image Caption:MPs await the EU budget vote result in the House of Commons

"That's why I've said it should be at best a cut, at worst a freeze.

"Whatever the discussions we have today I will be trying to get a good deal for the British taxpayer, a good deal for Britain, one that I can put before the British Parliament, one that I can put before the British people."

Speaking through an interpreter, Mrs Merkel said European leaders always had to "do something that will stand up to public opinion back home".

"Not all of the expenditure that has been earmarked has been used with great efficiency... We need to address that," she said.

But pressed as to whether she would support a budget freeze, she added: "I beg leave to first discuss this with the Prime Minister.

"What is in my interests is that we use our money effectively."

Mrs Merkel also signalled her exasperation with Britain's isolation and threat to veto the EU budget later this month.

"My experience tells me that if somebody confronts you with an ultimatum, he may well be confronted with another one," she said.

"And, if you have 27 interests in the European Union that we want to reconcile, it's certainly not such a great idea to start with an ultimatum.

"You have to first and foremost try and find common ground, try and find a common foundation. The more ultimata we have, the less able will we be to find agreement, so I will not share in this discussion."